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New Harvard Business Review Article Argues “Stop Obsessing Over Pay Ratios” While Seeking Other Reforms

February 25, 2017

An article in Harvard Business Review this week argues that disclosure of pay ratios “may have unintended consequences that actually end up hurting workers” and that ratios are misleading “because CEOs and workers operate in very different markets” and there is no reason for their pay to be linked. The article, titled “Why We Need to Stop Obsessing Over CEO Pay Ratios,” by Alex Edmans, a professor of finance at London Business School notes that CEOs may seek to make their ratios look better through outsourcing, invest in automation and similar approaches. He notes that as companies have grown larger, CEOs matter more. For example, the influence over a $20 billion company (the average Fortune 500 firm size currently), of a CEO contributing 1% more to firm value than the next-best alternative is worth $200 million. He also notes that researchers have shown that the “six-fold increase in CEO pay since 1980 can be explained by the six-fold increase in firm size.” However, the same argument does not apply to workers because a CEO’s actions and decisions are scalable across the firm while other employees’ actions are typically not scalable in that way. He also mentions, as the Center has pointed out many times, that the pay ratio is not comparable across industries and the ratio is unduly costly to develop, with first year costs estimated by the SEC at $1.3 billion.

Instead of pay ratios, Professor Edmans suggests other disclosures such as disclosing the time horizon over which a CEO realizes pay. He also suggests disclosing the sensitivity of the CEO’s wealth to company performance, noting the impact of increases and decreases in the company’s stock price on CEO wealth and comparing an industry-adjusted dollar value in the increase of the firm’s value compared to CEO pay.